You Want to be Where Warren Buffett Is
Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Hockey legend Wayne Gretzky, known as "The Great One," once attributed his success to, "I skate to where the puck is going to be, not where it has been."
That is obviously very sound advice for investing, too. Warren Buffett, head of Berkshire Hathaway (NYSE: BRK-A), and David Einhorn, head of Greenlight Capital (NASDAQ: GLRE), are two of the best investors in history; and have long been involved in the reinsurance industry. Steve Cohen, head of SAC Capital Advisors LP, another "great one," recently launched a a reinsurance company to be based in Bermuda, a preferred domicile for many in that sector. Hedge fund managers John Paulson of Paulson & Co. and Dan Loeb of Third Point LLC are also investors in reinsurance firms.
The basic appeal of any insurance entity is its ability to maximize the time value of money, the goal for investing in any asset for profits, with the concomitant optimization of the "playing of the float." To profit, an insurance company collects the premium income and then invests it. What is left over from the premium income and investing proceeds after the expenses and claims are paid is the profit for the entity. When a Warren Buffett or David Einhorn is doing the investing, that can be very lucrative.
For the offshore reinsurance industry, the main attraction is that it involves a great deal of money with not a whole lot in the way of regulation. This was best set out in "The Rainmaker," a novel by John Grisham. In "The Rainmaker" a lawyer fresh out of law school, Rudy Baylor, is forced to go to work for an ambulance chaser. One of Rudy's clients sues Great Benefit, an insurance company, in a bad faith lawsuit and wins a judgment of $50.2 million. During the trial, it was uncovered through the discovery process that Great Benefit had instituted a program of denying claims so as to increase revenues, betting that rejected policy holders would not take action.
According to the testimony of a former employee, Great Benefit generated an additional $40 million in revenue from that bad faith practice. Despite rejecting a handsome settlement offer from Great Benefit and then winning a verdict at a jury trial under a sympathetic judge, Baylor and his client never collected a dime from Great Benefit as it turned out to be a front operation for foreign financiers who had to declare bankruptcy due to losses in foreign exchange trading. Such are the rewards, and the risks, of the offshore reinsurance industry, providing young Mr. Baylor, Esq. a very costly yet invaluable lesson he could never hope to learn in law school!
While there are many fine and reputable publicly traded reinsurance companies such as Transatlantic Holdings (NYSE: TRH), Partnerre Ltd (NYSE: PRE) and Everest Re Group Ltd (NYSE: RE), probably the best way to invest in the industry is through Berkshire Hathaway. When investing in reinsurance, which any shareholder in Transatlantic Holdings, Partnerre Ltd, or Everest Re Group would be doing, depth and diversity is definitely required in the holdings. At present, Berkshire Hathaway has a market capitalization of over $206 billion with a portfolio of investments spanning from utilities (MidAmerican) to railroads (Burlington Northern Santa Fe) to consumer goods (Coca-Cola and Kraft), among many others.
By contrast, Greenlight Capital Re only has a market capitalization of just under $1 billion. The market capitalization for Transatlantic Holdings is $3.5 billion. For Partnerre Ltd, the market capitalization is $4.87 billion. At Everest Re Group, the market capitalization registers at $5.48 billion.
Here the lesson of Lloyds of London, the legendary British insurer, commands the attention of all investors. In the 1990s, Lloyds of London assumed a reinsurnace position for asbestos claims in the United States. As detailed in the article "How asbestos brought Lloyd's of London to its knees in the 90s" in The Telegraph on April 20, 2011, this resulted in the "...bankruptcy of thousands of Lloyd’s investors who had underwritten policies exposed to billions of pounds of asbestos-related claims. These included so-called "names," private individuals who agreed to take on the liabilities associated with insurance risks in return for any profits made from premiums."
Again, depth and diversity is required in the investment portfolio when buying shares of reinsurance companies. One improperly hedged hurricane, earthquake or asbestos position, and investors are denuded. At Berkshire Hathaway, the insurance companies in the holdings have contributed about $70 billion in dividend income and other proceeds for Buffett to invest. That is just the capital available for investing, not the total assets. The combined market capitalization of Greenlight Capital Re, Transatlantic Holdings, Partners Re and Everest Re Group is under $15 billion. When investing in reinsurance, it is best to "go big or go home." There is no better way to do this than with Warren Buffett, possibly the all-time "great one" in investing.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article.